The US Federal Reserve meets in another two days (September 16/17) to make what may be its first rate hike in nearly nine years. That decision, which will mark a u-turn in its policy making for many years now, has proved quite hard to make.
The difficulty of raising interest rates by any central bank, after a prolonged period of either standstill or fall, has often been highlighted using the imagery of turning an oil tanker around. You can’t do it abruptly, you have to do it gingerly, goes the prevailing wisdom. But what was touted as ‘extraordinary’ and ‘unconventional’ monetary policy measures taken in response to the global financial crisis in 2008 (following the collapse of Bear Stearns and Lehman Brothers), when the US Fed cut its short term rates from 5 per cent to near zero per cent by end-2008 — has now become normal. And financial markets have got used to the stimulus to such an extent that the very whisper of withdrawal from the world’s most powerful central bank led to ‘tantrums’ two years ago. Well, markets have certainly had two years to prepare for this inevitability and can certainly not complain about suddenness, if the decision to hike is taken on Thursday.
US economyTypical of most such central banking decisions, there are data points that argue for both a hike as well as sticking to status quo.
Some say that the US economy has started growing at a good pace and the level of unemployment has started coming down. Unemployment levels currently at 5.1 per cent are half of what they were in 2008. Ergo, it is time to raise rates. There are others (including the IMF and World Bank) which advocate caution, saying rate hikes should be postponed because the signs of a sustainable recovery are still not clear and global economic outlook for the next year remains weak.
The Fed has said that while there is some improvement in the US labour market indicators, such as wage gains and labour participation rates (the number of part-timers, the number of people quitting, the number of people looking for new jobs, etc.) are still weak and remain at levels below that seen a decade ago.
Housing data also remain weak as also capital expenditure by businessmen.
Besides, inflation levels in the US have been much below their target of 2 per cent, helped partly by lower oil and commodity prices, although these could disappear soon. And of course, a hike could always see a pullout by investors from emerging markets (of whom India is one) which could be disruptive for both equity and bond markets worldwide.
While these fears may be legitimate, they cannot, of course, dictate a policy of inaction for the Fed.
As experts point out, there will always be a negative reaction when central banks raise rates, given the markets’ predilection for cheap money. So, the Fed will have to bite the bullet – and soon.
One critical factor in these calculations — although that may not be voiced by the Fed in its statement — is that 2016 is an election year in the US, as President Obama winds up his term. There will be pressure on him to weigh on the Fed not to precipitate matters for his party hopefuls by increasing rates closer to the election.
Election impactYet, if rates don’t come off the rock bottom that they are now at, all claims that his policies have led to an economic turnaround may fall flat at the ballot box.
Besides, a rapid and substantial hike next year carries the risk of stalling whatever recovery is underway. Practical politics will therefore, demand that the rates start moving up from now onwards to give time for the economy to absorb mild increases. It’s time for those baby steps towards normalcy from the Fed.